Conditional Control: The Consequences of Expanding Creditors’ Right to Initiate Bankruptcy

We study the effects of a court decision granting creditors the power to force into bankruptcy corporate debtors whose liabilities exceed their assets even if they are current on their payments. We find that bond (stock) prices responded positively (negatively) to the court ruling and that firms affected by it did not reduce their risk, but increased their net worth through equity injections and aggressive accounting. As a result, the informativeness of these firms’ financial reports decreased. We conclude that the benefits from some measures of creditor empowerment may be mitigated by borrowers’ incentives to present overly-optimistic financial reports.